Sunday, April 26, 2009

Tanker sector in the crisis - a comparative position

The tanker sector was the last of the three major shipping sectors -containers, dry bulk and tanker - to be hit hard by the crisis. Because of the strict vetting system and pollution laws, it has the highest operating standards. There is specific legislation that compels removal of older tonnage from the fleet. The companies are generally older and more mature with stronger balance sheets and reserves than listed companies in the other sectors. Most tanker companies have been less aggressive in expansion than their counterparts the other two sectors. The order book is large, but smaller comparatively with the other two sectors and there is compulsory phase out of older single hull tonnage and stricter age limitations. There is definitely an over capacity problem that needs to be worked out and some over extended companies.

Tanker companies have generally been pioneers in shipping. They developed the concept of very large vessels. They made great strides in hull design with double bottoms, segregated ballast and double hull. They developed innovative cargo system designs to carry specialty cargoes like LNG, LPG, chemicals and clean petroleum products.

They were also innovative financially. Companies like OSG were among the first to go to public markets. In the latest upturn, they were among the first to expand. Genmar did an early block vessel acquisition from Metrostar. OSG bought out Stelmar. These were timely acquisitions, taking advantage of the upward market cycle.

Ironically, Top Ships - a laggard, under-performer in the sector- was one the first listed companies to restructure with its lenders, selling off a large part of its fleet in 2008 to de-leverage and improve liquidity. It was a timely move.

The tanker sector was not as hard hit in the fall of 2008 as its counterparts in other sectors. Rates were down, but not catastrophically low. For a time, the sector benefited from extreme contango, where there was an increased demand for storage and the winter season. Perhaps, however, this storage demand contributed in part to the current market conditions where the fall in activity and freight levels has really begun to bite hard. The clean product market has been dismal lately and the fallout is impacting negatively also the chemical trades.

Since most tanker companies have stronger balance sheets than their shipowner brethren in the other two sectors, they in a better position to weather the storm. The extreme case is NAT, which is entirely free of senior debt and carries only market risk. Others like OSG have over US$ 1 billion in liquidity. So far there have not been dilutive new capital raises to pay down down debt and cover losses as has been endemic in the dry bulk sector.

With major oil companies as customers, their counter party default risks are smaller that the dry bulk sector, although there are some disturbing rumors about charter payment delays lately. They also are generally less exposed to massive asset impairment from large block vessel acquisition and M&A deals late in the cycle, where many dry bulk owners have taken big losses. Tanker values, however, are beginning to fall as a faster pace than previously.

BLT is a notable exception buying out Chembulk (former MTM) at a mark up price from AMA with heavy debt finance very late in the cycle. Eitzen has been struggling from overexpansion. The Arlington merger with Genmar was a timely sellout, but it is relatively small deal for Georgiopoulos Group done on a conservative basis. Frontline may have some problems with their block acquisition of the TOPS Suezmax fleet. The vessels are older and said to be without center bulkheads, not the most desirable tonnage to have in this market.

We can only hope that the current low oil prices will lead to new demand soon and the needs for crude oil prove more inelastic than other sectors. Emerging economies like China and India are more oil intensive than Western developed countries. A growing number of oil producers will be in need to export more for their growing domestic needs. Seaborne transportation distances for crude oil are likely to remain large.
Some economists are predicting a pick up in economic activity by the end of 2009, but others feel than 2010 will be a lackluster year. In the meantime, there is certainly going to be some restructuring and consolidation in this sector.

Tuesday, April 21, 2009

DRYS after completion of its US$ 500 mio capital raise

DRYS has been in cross currents for some time. It has been suffering from over leverage, losses from newbuilding cancelations, charterer defaults and asset impairment from its acquisition of OceanRig. Now that it has completed increase of capital, its default risk is diminishing and this is likely to have a positive effect on its near term share value.

Increase of capital is dilutive to existing shareholders, especially if done at discount to prevailing share price. DRYS chose to raise additional capital slowly over several months by selling new shares at prevailing market prices. Whether this will add value to the company depends on the use of the funds. Under pressure of senior lenders for default on loan/ asset coverage warranties, these funds are likely to be used to pay down debt. This reduces leverage and default risk.

For this reason, Scott Burke of Oppenheimer recently upgraded the stock to 'outperform'. He also felt that DRYS might have some upside due to firmer freight levels in spring dry bulk markets. I think that he may be overshooting on the freight markets as there has been lately signs of weakness. China seems to be experiencing a hard landing. This does not bode well for an immanent dry bulk market revival.

I continue to feel that a major issue in DRYS that could affect the stock positively would be a successful spin off of its OceanRig offshore drilling business.

Otherwise, it continues to be a battle of attrition and endurance for all shipping companies until there is real improvement in freight market fundamentals.

Tuesday, April 14, 2009

Will the Liquidationists get their revenge?

US monetary authorities are following Keynesian remedies as never before. The FED has expanded dramatically its balance sheet and moved to radical 'quantitative easing' including purchases of US Treasuries. Administration economists like Christie Romer cite Keynes with almost religious devotion. Massive government subsidies and expanded entitlement programs are back in vogue. Will this stem the crisis and lead to a speedy and robust economic recovery? Alternatively, will this lead to unanticipated side effects, that result a prolonged period of stagnant growth leaving the US a poorer, weaker country?

The Liquidationists of the Great Depression era may soon take their revenge on today's concepts of financial engineering and risk-taking. Anti-Keynesian economists like Joseph Schumpeter believed in ‘creative destruction’ and argued that there was a “presumption against remedial measures which work through money and credit.… policies of this class are particularly apt to…produce additional trouble for the future.” The approach of the Liquidationists was to write off the losses where they occurred because they feared the negative side effects otherwise and wanted to make room for new players. They believed the role of government in the economy was to secure a level playing field. They advocated balanced budgets and low public debt. Today we live in a world where government plays an increasing role in socializing losses and regulating business by public policy. Debt inflation is key tool used by US authorities in the current financial crisis.

The Obama administration is continuing the policies of the previous Bush administration in subsidizing the US banking industry rather than having financial institutions holding so-called subprime 'toxic waste' write off the bad paper. The US government is effectively socializing the losses in the banking sector, shunning the conventional remedies of bankruptcy, bridge banks and reorganization and replacing this with elaborate subsidy schemes for recapitalization. The hope is that by massively increasing the money supply, prices will again begin to rise in the housing markets and the banks will be made whole again on their bad assets.

The new twist to the Obama administration is the return of big government to the broader US economy. What Obama proposes is a "post-material economy" de-emphasizing the production of ever-more private goods and services and harnessing the economy to achieve broad social goals. The logic of the "post-material economy" is to spend heavily and finance this by an expansion of public deficits and debt. Government policy would play a strong role in credit and capital allocation. The theory is that the deficits and public debt that would be eventually paid off by a robust economic recovery based on this new economic paradigm

The risks are that the resulting debt inflation in both government and households as well as increased tax load will crowd out demand for goods and services and lead to prolonged period of economic stagnation in the US. The US tax system favors debt rather than equity financing. By encouraging debt, it has prompted a tax shift onto the “real” economy’s labor and capital. The resulting interest charge and tax shift mean that US is not as efficient and low-cost producers as it used to be.

To get a lower-cost world, the US has to counter political pressure from real estate owners and their bankers to shift taxes off rent-yielding properties onto labor and capital. Income and sales taxes add to the price of doing business, and hence reduce their supply and competitiveness. By contrast, the FED is trying to reflate real estate asset prices to safeguard an over-sized financial industry

It is very difficult to have a productive economy that creates wealth and value as well as broadens the tax base without robust a goods and services sector that rewards capital and labor. This simply will not happen if people’s incomes are cannibalized by taxes and debt service from socialization of the financial sector losses and government-guided post-material economic policies. The room for discretionary spending will shrink. The debt inflation and high tax burden risks ever-higher breakeven levels for US businesses and households, making the US very uncompetitive internationally.

The present crisis was generated from the excesses in dealing with the aftermath of the Dot.com bubble. The excesses from the present financial engineering and new government economic policies are yet to be quantified. The Liquidationists feared the success of capitalism would lead to a form of corporatism and a fostering of values hostile to capitalism -especially among intellectuals - that would lead to capitalism's demise. Democratic majorities would vote for the creation of a welfare state and place restrictions upon entrepreneurship that destroy the capitalist structure.

They would probably turn over in their graves today because this thinking now reflects a good part of the existing political and economic landscape in the US. The real issue for the US economy is competitiveness and productivity that creates new wealth and value. It is very hard to see anything at present in the Obama administration that fosters the entrepreneurship needed to lead to this result.

Monday, April 13, 2009

A new era of political alchemy?

Clean energy is the present buzz word that excites voters. Obama believes in political expedience. He is a politician, trained as a lawyer. He is not an economist or an engineer interested in feasibility or efficiency, nor does he care. He uses government money to sponsor this. He may well put lame-duck US auto companies like GM on subsidies to produce such vehicles. There is no guarantee, however, that the technology employed will succeed. Generally out of 10 high tech projects, only two new technologies prove viable. There is still the formidable commercialization challenge.

The real issue for the US economy is competitiveness and productivity in goods and services that creates new wealth and value.

The Obama administration is continuing the policies of the previous Bush administration in subsidizing the US banking industry rather forcing them to write off the bad loans and take the losses. The hope is that by massively increasing the money supply, prices will again begin to rise in the housing markets and the banks will be made whole again on their bad assets.

The new twist to the Obama administration is the return of big government to the broader US economy, financed by deficits and public debt. The theory is that the debts will be paid off by breakthroughs in new technologies like green energy.

The risks are that the resulting debt inflation in both government and households as well as increased tax load will crowd out demand for goods and services and lead to prolonged period of economic stagnation in the US.

In such a scenario, there will be little demand for green cars because people will not be able to afford them, even if a reliable technology is developed and proven cost efficient.

The US will become less and less competitive with the rest of the world, which proves more effective in use of resources. Whatever is produced in the US will cost far more unless there is a massive depreciation of the US dollar.

Unlike FDR, Obama is coming into his presidency at the beginning of the crisis. The future of his presidency depends on his abilities to manage it.

Excel (EXM) restructuring results in massive share dilution

The EXM restructuring resulted in massive share dilution. Absent a significant upturn in the dry-bulk market over the medium term, the Panayiotides family capital injections of US$ 45 mio at a deep discount of US$ 1.75 per share left little, if any, equity value remaining in the company for public shareholders. Yet the stock share value has been soaring due the market perception that the company has been relieved of immediate default risk. Excel shares are worth approximately 60% of the previous valuation after the equity dilution but the risk of going to zero is diminished.

The EXM loan workout plan got mixed reviews with stock analysts and even one downgrade after an earnings announcement.

The successful waiver negotiations and principal repayment deferral were seen as positive signs for the viability of the group. It demonstrates that banks are swilling to work with shipowners and do not yet have an appetite for seizing vessels Generally things tend to get nasty later in the downturn cycle as weak market conditions persist and banks start looking to liquidate the losses to get them off their books.

As it stands now, the Panayotides family's stake in Excel increases to 47% from the previous 11%, and boosts the overall share count by 69%. Excel shares are worth approximately 60% of the previous valuation after the equity dilution but the risk of going to zero is diminished. The negotiated waivers and deferments essentially remove the possibility of foreclosure until 2011, widening the time horizon for recovery. Further the restructuring terms give the group enough cash liquidity to pay for newbuildings (US$ 110 mio) and debt repayment (US$ 207 mio) out of an expected cash flow of roughly US$ 300 mio.

A successful outcome depends on future market conditions. If conditions remain weak and the group is plagued with a new rash of charterer defaults, they could be looking for a new capital infusion down the line. If conditions improve, there could be real potential for shareholders to recoup some of their losses.

Most analysts cautiously kept their previous ratings. The day after the bulker owner posted a US$ 329 mio quarterly loss, however, Maxim's Charles Rupinski cut his rating on Excel's New York-listed shares from "buy" to "hold". He stressed that EXM continues to be a highly volatile play in the dry-bulk industry, especially as its recent debt restructuring gives the company further staying power in terms of liquidity over the next several quarters; but cautioned that with its high debt load, the company will need sustained improvements in the overall dry-bulk market to work as a value proposition.